Question

An investor wants to earn a 10% return on a stock she buys for $50 today. The stock just paid a dividend of $1.00 per share. What must be the annual growth rate in the dividend if she is using the dividend discount model to price this stock? 10 points

BAII PLUS

Answer 1

Given about a stock,

Price today P0 = $50

last dividend, D0 = $1

required rate of return on stock r = 10%

Using dividend discount model, price can be calculated as

P0 = D0*(1+g)/(r-g)

So here, 50 = 1*(1+g)/(0.1 - g)

=> 50*(0.1-g) = 1+g

=> 5 - 50g = 1 + g

=> g = 4/51 = 7.84%

So, annual growth rate in dividend is 7.84%

Dividend discount model has a formula that can directly be used, so only calculations needs to be computed on a calculator. So, this can even be solved without a BAII calculator.